"Completing the Accounting Cycle", Part II

Financial Statements and GAAP Principles

GAAP Conventions

  • Comparability and Consistency

    • Financial statements should allow users to identify similarities, differences, and trends over time and between companies.
    • Consistency in accounting principles is essential for comparability.
    • Example: Using the same depreciation method consistently.

  • Materiality

    • Relates to the significance of an item to the business.
    • Must follow GAAP standards for material items.
    • Levels of materiality vary.
    • Example 1: $100 difference in a $1,000 cash account is material.
    • Example 2: $500 error in $1,000,000 revenue is not material.

  • Cost Benefit

    • The benefits of providing accounting information should outweigh the costs.
    • Benefits > Costs.

  • Full Disclosure

    • All relevant information about the business must be disclosed.
    • If the cost of including information on the financial statements outweighs the benefits, it should be included in the notes to the financial statements.

  • Conservatism

    • Choose the method that is least likely to overstate assets and net income when faced with uncertainty.
    • When in doubt, be conservative.

Classified Balance Sheet

Purpose

  • Provides a more understandable format for users.
  • Aids in assessing liquidity and profitability.

Components

  • Assets: Resources.
  • Liabilities: Obligations.
  • Owner's Equity: Claims.
  • Classified balance sheets categorize assets, liabilities, and owner's equity into subgroups, unlike unclassified balance sheets.

Asset Categories

  • Current Assets

    • Most liquid assets.

  • Long-Term Investments (Long-Term Assets)

  • Property, Plant, and Equipment (PPE)

  • Intangibles

Liabilities and Owner's Equity Categories

  • Current Liabilities

  • Liabilities

  • Owner's Equity

    • Partnerships: Multiple capital accounts (one for each partner).
    • Corporations: Shareholders' or Stockholders' Equity.

Current assets

  • An asset is current if it will be converted into cash or used up within one year or the operating cycle, whichever is longer.
  • Operating Cycle: The time it takes to generate revenue and collect accounts receivable.
  • Assets listed in order of liquidity.
  • Cash and cash equivalents are considered equivalent to cash.

Long-Term Investments

  • Assets that will be converted into cash or used up after one year or the operating cycle.
  • Assets not currently used in operations.
  • Example: Land held for future use.

Property, Plant, and Equipment (PPE)

  • Tangible assets (physical substance).
  • Depreciated assets.
  • Historical cost rule applies.
  • Except for land, all PPE assets have an accumulated depreciation account (contra-asset).
  • The matching rule is applied when allocating the cost of the asset over its useful life.

Intangibles

  • Assets without physical substance (rights).
  • Currently used in operations.
  • Expensed through amortization expense.

Liabilities

  • Current Liabilities: Obligations to be paid within one year or the operating cycle.
  • Long-Term Liabilities: Obligations to be paid after one year or the operating cycle.
  • Current liabilities are paid off our current assets
  • Long term liabilities are paid off our long term assets

Stockholder's Equity

  • Sole Proprietorship: One capital account.
  • Partnerships: Separate capital account for each partner.
  • Corporations: Common stock and retained earnings.